Responsible Investor (22.04.2020) - An investor who focuses solely on low carbon emissions could end up investing in polluters, while excluding some of the most important providers of solutions to the climate emergency.
There is no doubt that the enforced disruption to modern living caused by the Coronavirus outbreak will have sharp environmental benefits of a size that few activists could have hoped for in the modern-day economy. The question now is how long this green living environment can continue and whether some of these positive attributes can provide building blocks for a world that will never be quite the same.
There are certainly some indications that the market believes in the long-term potential of listed market champions of sustainability.
An investor preference for sustainability champions is probably not the whole picture. Since the beginning of the year (to 23rd March) the list of best and worst sectors is predictable. Using the MSCI ACWI as a benchmark, Consumer Staples have fallen 22.4% and Telcos 22.8% whereas Energy is down 54.5% and Financials down 40.1%.These short term, sharp moves cannot be attributed entirely to a sustainability pecking order and indeed it would be surprising if during a period of such intense crisis the world prioritised long-term adjustments of (over) short-term support.
The key beneficial outcomes caused by this unprecedented interruption to modern living fall particularly on emission levels. The number of stark anecdotal observations grow by the day. For example, one of the globe’s busiest toll roads, the 407 ETR in Toronto, Canada, reported a fall of as much as 66% in traffic year on year. This global change in economic activity is having significant organic health benefits. For example, the number of lives saved through lower air pollution in major Chinese cities is estimated at twenty higher than those lives lost to COVID-19 (Stanford University).
However, not everything is quite so supportive of the green economy. Policy makers are currently forced to prioritise stimulus that can alleviate the worst of the current stresses in society. Consequently, fiscal and monetary measures are unlikely to be aimed at green industries where the payoff tends to be slower to come through. Yet, whilst an increase in green incentives is not a priority and indeed some major policy moves like the EU Green Deal may see delays, these measures are being substituted by other socially supportive policies, for example unemployment benefit and debt forbearance. Some commentators have noted the contrast in the response to the Coronavirus versus the Global Financial Crisis in terms of the social standing of the intended beneficiary and the directness of that response. To some degree the financial response to the GFC most significantly impacted the wealth of those that needed it the least whilst consigning the man on the street to a near decade of flatlining or declining financial prospects. The response to this crisis has clearly focused on support (supporting) individuals and small businesses, in some cases at the expense of big business and markets.
In other words, therefore it is important to differentiate between necessary steps made by governments and central banks in a crisis and structural shifts that may see their timeframes altered, either shortened or lengthened by these unprecedented times.
One of the key frustrations of the green movement is the slow pace of serious structural change. To an extent this is a natural consequence of the plethora of different stakeholders that are involved. A large sovereign wealth fund, a non-governmental organisation and a major investment management firm, to list three of many players, will have very different priorities when it comes to the green agenda. The sovereign wealth fund may wish to report the impacts its investments are creating whereas the investment manager is focused on building scale of AUMs. These differences in priorities have led to the creation of a number of bodies, all of which have credible terms of reference and memberships but through multiplication of approaches have slowed down the pace of change.
Equally, approaches to measurement can be broadly categorised into systems that aim at achieving the largest number of respondents through the employment of basic impact measurements on the one side. Often these are criticised for being too elementary. On the other side lie a number of frameworks focused on more precise data points but whose demands are too onerous for many investee companies currently not set up to disclose in such granularity. In this fluid environment, a large number of companies have reached out to consultants to map their operations to Sustainable Development Goals and produce favourable measurement criteria. This is something of a concern as the proliferation of data points with little oversight or standardisation does not help propel the financial system to a higher plane of disclosure. Some initiatives are, however, more constructive, for example the Science Based Target Initiative provides a clear roadmap for companies wishing to develop their sustainability disclosure. Equally, certification as a B corp gives a company the necessary incentive to reassess every aspect of their corporate footprint as 3,300 companies before them have already demonstrated.
In summary, the current environment provides both opportunities and headwinds to the sustainability and impact industries.
The pace of regulatory change will no doubt slow whilst the coronavirus crisis rages; data disclosure will probably not improve at the same speed as may have been expected six months ago. But the natural forces of change are likely to see profound support drawn from some of the organic consequences of this global pandemic. It will take some time to understand whether society will permanently embrace these changes for the better.
Rupert Welchman
Co-Manager of the Positive Impact Equity strategy
Take the example of Xinyi Solar Holdings, a Chinese company that is among the world’s leading solar glass manufacturers. It also owns and operates solar farms. According to MSCI, its carbon emission intensity is 1,627 tons of CO2 per USD million of sales. The figure for Royal Dutch Shell is 218. So for investors trying to reduce the carbon footprint of their portfolios based on this data alone, it makes perfect sense to buy Shell and sell Xinyi Solar.
Except that of course carbon emissions produced by using Shell products are estimated to be around 8 times the figure considered by MSCI. And assuming that the 2.5GW of solar farms that Xinyi Solar operates replace coal power plants, this would avoid nearly 2.1m tonnes of CO2 emissions annually. That is, 2,143 tonnes avoided per USD million of sales every year (as a bonus, 62,000 tons of SO2 emissions would also be avoided). Thus, when product-related emissions are considered, Shell’s carbon intensity is estimated at around 1,962 versus negative 516 for Xinyi Solar. In other words, as common sense would suggest, Shell is a big source of emissions while Xinyi Solar offers a solution.
Xinyi Solar is not unique in this respect.
Global leaders in many sectors that play a key role in solving the world’s environmental problems – such as renewable energy equipment, waste management, water treatment, utilities and recycling – emit large amounts of carbon. On the other hand, many companies whose products damage the environment have low carbon emissions according to the measures used by the industry.
It is no wonder, then, that a large provider’s low-carbon ETF is full of names like Coca Cola, Philip Morris, Caterpillar, Valero Energy, Vale, Rio Tinto, Halliburton and Raytheon. In fact, the biggest clean energy company in the portfolio is Vestas, with a tiny weighting of 0.05% (probably because a large proportion of Vestas’ manufacturing is subcontracted, which means that its own emissions are low). If an investor chooses a low-carbon fund with the intention of helping the environment, this portfolio is unlikely to be fit for purpose.
This is probably less of an issue for institutional investors, which will look beyond carbon data alone when selecting funds. It is a bigger problem for retail investors, who lack the resources to do this. They rely on fund selectors to be gatekeepers. A worrying trend in this respect is for fund selectors to adopt cut-off points for portfolios’ carbon intensity, thus excluding funds with higher carbon intensity. For the reasons explained above, this could be doing a disservice to their clients.
Until better data collection, monitoring and measurement methods emerge, the finance industry should not just rely on reported carbon data. It should develop more sophisticated and holistic methods to measure the environmental impact of portfolios.
Eli Koen
Portfolio Manager Emerging Equities
